WRAPUP 1-Subtle divergence in approach to Fed policy on display

February 12, 2013|Reuters

By Jonathan Spicer and Paul Day

NEW YORK/MADRID, Feb 12 (Reuters) - The subtle tug-of-war ofU.S. monetary policy was on full display on Tuesday as one topFederal Reserve official said timidity could complicate thecountry's already weak economic recovery, while another warnedabout the risks of being too bold.

Atlanta Fed President Dennis Lockhart, speaking in Madrid,predicted the U.S. economy would remain weak and cautioned thatunemployment, at 7.9 percent last month, could become entrenchedif left unaddressed.

"A sense of urgency is appropriate," said Lockhart, acentrist who does not vote on Fed policy this year. "Ifpolicymakers are too patient, what started as cyclical problemscan evolve into structural problems."

While Lockhart's view is in the majority of the U.S. centralbank's 19 policymakers, including that of Fed Chairman BenBernanke, there are also a handful of more hawkish voices whoare less comfortable with the aggressive policies adopted tospur growth and hiring.

Kansas City Fed President Esther George, a voter whodissented at a Fed policy meeting last month, said the Fed coulddisrupt markets if it actively sells large amounts ofmortgage-backed securities when the time comes to tightenmonetary policy.

Addressing an audience at University of Nebraska-Omaha,George also warned that investors could question the centralbank's commitment to its 2-percent inflation goal if inflationexpectations begin to rise.

When the time finally comes, "actively selling a largeamount of agency mortgage backed securities ... could bepotentially disruptive to markets and market functioning," shesaid, adding: "These actions are untested."

Both Lockhart and George largely repeated commentspreviously made on the Fed's policies, which include near-zerointerest rates likely over the next couple of years and $85billion in monthly purchases of Treasury bonds and mortgagedebt.

Bernanke has defended the Fed's aggressive easy-moneypolicies, arguing the economy needs to grow quicker to lowerunemployment and withstand tighter fiscal policies and threatsfrom abroad. He and others say the economy, especially interestrate-sensitive sectors like sales of homes and automobiles, hasresponded to monetary policy.

"While we've made progress, there's still quite a ways to gobefore we'll be satisfied," Bernanke said in January.

Yet the slow overall recovery has cast some doubt on theU.S. central bank's far-reaching strategy, with some, includingsome Fed officials and congressional Republicans, warning thatthe multi-trillion-dollar quantitative easing efforts riskfuture inflation and could crimp the Fed's ability to tightenpolicy when the time it right.

The U.S. economy likely expanded only slightly in the fourthquarter, despite an early government estimate that GrossDomestic Product (GDP) unexpectedly fell at a 0.1 percent rate.As it stands, overall growth was just 2.2 percent in 2012, belowthe 3-percent pace to which the United States is accustomed.

In adopting these thresholds, the Fed has expressed sometolerance for having the inflation outlook exceed its 2-percentgoal, George said on Tuesday.

That in turn "carries with it the risk that longer-terminflation expectations may flip above levels consistent with"the goal, and "cause the market to question the FederalReserve's commitment to its inflation goal," she said.

Nonetheless, Lockhart said he expects the Fed will need tocontinue its asset buying into the second half of this year inorder to keep pressure on long-term interest rates, andencourage investment and hiring.